Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

VI. A New Framework: the EBEX Indicators

as many better executions before as after the execution of the order. In this case, the intermediary could have traded at any other time to provide better execution. This specific case can also refer to the outstanding situation where both NBBEX and NABEX tend to zero. This should mean that the intermediary chose exactly the right moment to trade and that his market timing was perfect. In this last specific situation, the zero directional EBEX is accompanied by a very high absolute EBEX score. When investors give their intermediaries discretion over how they implement their trades, they like to assess whether their trades are well timed. As we have just seen, the directional EBEX offers a straightforward and easy-to-interpret measure of the quality of the market timing that varies from –1 (too aggressive) to 1 (too slow) and makes it possible to gauge the intermediary’s use of the discretion he has been granted. This point is relevant as pre-trade analysis should help intermediaries predict likely market conditions and define an appropriate trading strategy. However, to be really relevant, the directional EBEX assumes that the intermediary has full discretion about how he fills the order within a given time window and that he does not systematically execute the order at the end of the specified period. The first assumption is realistic since many brokers are often given the market close as a deadline. The second assumption depends more on the intermediary’s commitment to best execution.

intermediary to assess the consistency his market timing. Again, comparative analysis across several intermediaries may be done based on directional EBEX distributions wherein the score of each intermediary is a risk-adjusted performance computed as the mean value of EBEX divided by its standard deviation. An active trader will be expected to provide an average directional EBEX as close to zero as possible with the lowest standard deviation. (3) $EBEX In addition to the two fundamental indicators that measure the quality of execution and the quality of market timing, we have developed a third indicator, known as $EBEX, whose purpose is to indicate the cost to the investor of the intermediary’s trading performance. In short, this indicator likens the absolute EBEX scores reached by intermediaries to an opportunity cost for their clients. The $EBEX is computed trade-by-trade for a given absolute EBEX that is defined arbitrarily or, when possible, corresponds to the performance objective set by the investor. Take, for example, an EBEX target of 0.75 specified by the investor. To determine the total cost implied by the quality of execution achieved by his intermediary, we focus only on the trades with an EBEX lower than 0.75 and we compute trade-by-trade the signed difference between the actual execution price and the price that would have yielded an EBEX of at least 0.75. We then multiply each price difference by its corresponding trade size and add up all the weighted price differences to get the $EBEX indicator. To facilitate interpretation and allow meaningful comparisons, we express the $EBEX in % of the total monetary

Much as with absolute EBEX, we may analyse the distribution of directional EBEX of an

75 An EDHEC Risk and Asset Management Research Centre Publication

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